FOMC Statement & Potential Impact on Fixed Income

Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):

Consistent with our and the market’s expectations, the Federal Open Market Committee (FOMC) increased the Fed Funds rate range to 1.75%‐2.00%.

The June statement was moderately more hawkish than the market had anticipated. The Committee emphasized the solid growth and inflation backdrop. The Fed effectively dropped its forward rate guidance by removing language in the statement on the need for the Fed to keep the Fed Funds rate below longer-run levels for “some time”. The statement continues to emphasize the Committee’s symmetric inflation objective. The Fed statement did not reference the balance sheet but the process will continue in the background. In June, the maximum run-off per month will remain unchanged at $30bln ($18bln Treasury/$12bln MBS).

Due to a steady upward drift of the effective Federal Funds rate within the trading band, the Committee made a technical adjustment to ensure the actual rate continues to trade in the middle of the 1.75 – 2% band. They did this by raising the lower end of the band (the rate on the Fed’s overnight reverse repo facility) by 25bps while only raising the upper end of the band (the interest rate on excess reserves held at the Fed by 20bps). This technical shift will likely not occur again, at least in the near term, and does not reflect a change in the stance of monetary policy.

Committee Statement

We can break the statement into three parts:

Economic Assessment – the Committee upgraded its assessment on growth highlighting the strong labor markets, acceleration in consumer spending and continued business investment so far in the Q2 data. The Committee upgraded its inflation assessment, by removing reference to inflation expectation remaining low.

Forward Guidance – the Committee effectively removed their forward rate guidance language by eliminating the reference to the period of time of in which policy rates will remain below longer-run levels. At the same time, they continue to describe current policy as accommodative. Going forward, increases to policy stance will be strictly related to developments in employment and inflation. The Fed continued to emphasize the symmetry around inflation, suggesting continued progress has and was expected to be made but they would not yet declare complete victory.

There were no dissenters.

Summary of Economic Projections

Investors had priced in nearly 100% probability of a rate hike at this meeting, so the SEPs and the “Dot Plot” took on greater importance. Within the projections, the growth forecasts were mostly unchanged at this meeting after being upgraded to incorporate fiscal stimulus in prior meetings. The inflation forecasts were also mostly unchanged, with the exception of an upgrade to headline PCE in 2018 due to higher energy. The median forecast of core PCE continues to show a small overshoot above the Fed’s target in 2019 & 2020. The unemployment rate estimates were cut in 2018, 2019 and 2020, but remained unchanged in the long-run. The median dots increased in 2018 to a total of 4 hikes, as one member of the Committee increased their expectations. The 2019 median increased in parallel to the 2018 dot reflecting an additional 3 rate hikes next year. The 2020 and Long-run dots were unchanged.

Chair’s Press Conference

Chairman Powell made several announcements during the press conference. He signaled that every FOMC meeting would be followed by a press conference starting in January 2019. He projected confidence in the growth outlook. He explained that some of the communication provided by the FOMC during the financial crisis and the early recovery was less necessary as policy had moved away from the zero lower bound and normalization has gotten well underway. The Chair downplayed concerns around the lack of wage pressure, suggesting that while surprising, it was not abnormal and also downplayed the risk that inflation would accelerate much higher from here. The Chair emphasized that the adjustment to IOER was a technical factor. Regarding the Dots, the Chair stressed that the rise in 2018 should not be viewed too far out of context and that the shifts in the median forecasts were relatively small.

Our View:

The FOMC statement was reflective of a more confident Fed and a policy rate that has moved sufficiently away from extraordinary levels. Forward rate guidance will play less of a role in Fed policy going forward, and at the same time, the balance sheet will continue to progress in the background.

Evidence of further improvement on inflation toward and above the 2% objective will keep the FOMC tightening at the current pace.

Four open spots remain on the Board of Governors, although the White House has nominated two more Board of Governors to be approved by the Senate. Richard Clarida has been nominated for the Vice Chair position and Michelle Bowman has also been nominated to fill the role of having a community banker on the Board.

The change in the FOMC’s balance sheet has been widely publicized and well telegraphed and the knock-on impact to markets so far has been muted as the run-off remains minimal. We anticipate the size of the run-off in 2018 will be between $300 – $400 billion, dependent on MBS pre-payments.

We expect that the reduction in global central bank liquidity in 2018 will move more into the market’s purview as the year progresses and could cause an increase in volatility.

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